Defi 101

Centralized vs. Decentralized: Will DeFi Replace CeFi?

In a world where the majority of what we do and what we consume rely online, having no internet connectivity almost seems impossible. As of July 2020, almost 4.57 billion people are active digital users. However, even though China and India have a larger share of internet users, both of these countries reportedly had the world’s largest unbanked population.

Looking at the modern society we are in right now, major concerns like the availability of financial services must be addressed. Hence, as traditional finance transcends to digital finance, cryptocurrency now coexists with fiat currencies like the US dollar and British pound.

Amid the cryptocurrency landscape, both centralized and decentralized players prevail. As matters concerning verification, custody, exchange, and trust are considered, one obvious question pops into mind: will DeFi replace CeFi?

IN SUMMARY

What is Centralized Finance (CeFI)?

Centralized finance or simply CeFi deals with people conducting their financial transactions through a privately-owned institution. By trading, lending, or borrowing cryptocurrencies through these centralized parties, people can earn profit and interests and get their loans.

Nevertheless, CeFi is a form of neo banking, a digital bank without any physical branches. Going back in history, during the 19th century, the rise of trade and industry in the US-led to the establishment of powerful private merchant banks like J.P. Morgan & Co.

Eventually, central banks emerged to become responsible for managing currencies, circulating money supply, monitoring interest rates, and overseeing the commercial banking system. Later on, the international gold standard was developed and virtual currencies were born.

With CeFi, users trust the people who are running their preferred digital institution in storing their crypto funds and give them their utmost confidence to ethically manage these funds and execute the services that the business offers.

Examples of CeFi

Binance: the world’s biggest crypto exchange in the world by trading volume
Coinbase: a fully regulated and licensed US-based digital asset exchange and broker
OKEx: a world-leading digital asset exchange that provides advanced financial services
Libra: a global payment system and financial infrastructure proposed by Facebook Inc.
BlockFi: a crypto lending startup that provides crypto-funded interest accounts

Advantages of CeFi

Being in the financial game for quite some time, the main benefit of using CeFi services is flexibility. Flexibility in the sense that in terms of conversions, cross-chain functionality, ease of access, and liquidity, CeFi proves to be sustained; yet volatility and security risks are still there.

For instance, CeFi can provide things like company-wide financial audits of the treasury and create a familiar and user-friendly framework that has been tested and developed with the end-users in mind. More so, for commercial use, this is a ‘play safe’ option.

Derived from this flexibility include fiat conversions, cross-chain exchange, and the ability to get help from customer service.

  • Firstly, you can benefit from the convenience of others holding and securing your keys
  • Secondly, you can exchange assets with typically higher liquidity
  • Then, you can easily conduct cryptocurrency transactions and activities
  • Even more, mostly are KYC and AML compliant for security purposes
  • Not only that, a high level of customer support makes users assured of their funds
  • Finally, frequently traded coins/tokens are listed/supported here

What is DeFi?

Decentralized finance or simply DeFi is an innovative financial system built on top of open-source and distributed networks such as Bitcoin and Ethereum. As a result, it aims to offer a much better way to manage and offer current financial systems and services around the world.

We have a beginner guide talking exclusively about DeFi. To learn more about DeFi, read our article: What is Decentralized Finance (DeFi)?

In context, having no central point of control and third-party intermediaries, these systems claim to be immune to manipulation, fraud, and security issues. As a matter of fact, it aims to be adopted across various sectors as it is powerful enough to maintain reliable and transparent financial transactions.

With DeFi, users are choosing to trust the technology and its underlying functions (protocols, smart contracts, etc.) that would automatically execute the services they offer. With this, we are maximizing the power of computer codes in ensuring security and efficiency.

Examples of DeFi

Uniswap: a fully decentralized protocol based on Ethereum for automated liquidity provision

Yearn.finance: a yield aggregating platform based on Ethereum

Chainlink: a highly reliable decentralized oracle network

MakerDAO: a decentralized lending and stablecoin minting tool

Compound: a decentralized cryptocurrency lending and borrowing tool

Synthetix: a decentralized derivatives liquidity protocol

Is DeFi Better Than CeFi?

As it exceeded the $7 billion worth of TVL in August, the decentralized finance industry has seen a dramatic surge of interest. Subsequently, new platforms that promise to disrupt the way people manage, transact, earn and lend their money have been launched.

Much of this growth has been catalyzed by the meteoric rise of lending platforms, DEXes, and assets like Yearn.finance, Aave, Synthetix, and Uniswap.

 CeFiDeFi
VerificationRequiredNone
CustodyCustodialNon-Custodial
ExchangeCentralizedDecentralized
TrustTrustfulTrustless
Trading/LendingYesYes
StablecoinsYesYes
PaymentsYesYes
Fiat-to-Crypto YesNo
Cross-Chain SolutionsYesSome
TransparencyNoYes
Liquidity YesSome

Table of Comparison Between DeFi and CeFi

CeFi players have already built mainstream user experiences inside their exchanges but with the battle for decentralization getting stronger, they have figured out how to integrate DeFi products and services into their offerings.

Accordingly, leading exchanges such as OKEx have already started to do so by listing DeFi tokens. In addition, with the Binance recent mainnet upgrade, BNB staking services will also be available to users. These are all good steps taken required to drive DeFi adoption forward.

Top Decentralized Finance (DeFi) Coins (Source: coingecko.com)
Top Decentralized Finance (DeFi) Coins (Source: coingecko.com)

Without a doubt, the risks of DeFi protocols are correlated to their newness in the crypto scene. As seen on the chart above, the DeFi tokens have experienced momentous crashes of up to 30% loss for the past 24h.

Despite its bullish trend for the first half of 2020, DeFi still has a long way to go to be really trusted by the users. Based on the Diffusion of Innovation Theory, DeFi is currently in stage 2 (early majority). With this in mind, the community uses various DApps and protocols but with still low adoption.

As per the key findings of Coingecko’s survey, there are three major reasons why users are still hesitant to rely on DeFi completely: they are still dependent on banks, DeFi is still in its early stage and has a low adoption rate, and DeFi has yet to prove that it is more secure than banks.

In reality, there is an adequate room for DeFi developers to focus on making their applications more secure and resilient to cyberattacks, leading to an increase of trust in the DeFi ecosystem.

Decentralized Finance (DeFi) Survey (Source: coingecko.com)
Decentralized Finance (DeFi) Survey (Source: coingecko.com)

In view of the survey above, it shows that people are divided between wanting to go completely bankless or not. Moreover, it has been discovered that users who are more familiar with DeFi are more comfortable to become completely bankless.

In this case, better education for users on what safety through DeFi looks like is an important step to make them convinced of this technology’s prowess.

DeFi, at its core, holds the promise to allow the people more freedom and cheaper transaction fees when managing and using their assets and carrying out financial decisions. Due to this, many DeFi projects seem to provide users with equal benefits for borrowing and lending, high-yield interest income, and low-interest loans.

Some may think that choosing CeFi and its user-friendly interfaces is taking a step backward to innovation due to the risks of increased centralization on the hands of big exchanges. But some also argue that DeFi’s abrupt growth from a small base should be cause for concern.

Conclusion

Both DeFi and CeFi can go hand in hand in improving global financial inclusion. To answer our question above, it is still difficult to imagine a world where decentralized finance completely replaces the centralized entities.

Indeed, decentralization offers a promising ideal that can massively increase operating capacity, conduct economic activity on public blockchains, diversify investments between DeFi and CeFi assets, and democratize the financial system as a whole.

One without the other may signal an economic downfall that can be more detrimental than beneficial to the world. What is more likely to happen in the future is a correlation between the two, offering the best of both worlds to financial investors and ordinary users.

As more attractive yields, faster transactions, and reliable infrastructure continue to come to life, the financial arena as we know it now can become a better societal aspect. For that reason, it could have a valuable long-term impact on how our money-making system works.

CoinQuora Staff

CoinQuora is an online publication that aims to educate about news, exchanges, and markets in the cryptocurrency and blockchain industry
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